April 01, 2017

Managers need long-term vision for rail to prosper

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TOP management changes at two of the world’s major railways, CSX in the United States and German Rail (DB), were announced in March. While the circumstances around the new appointments could not be more different both are likely to herald a change of direction.

CSX is the latest North American Class 1 freight railway to succumb to the crusade by Mr Hunter Harrison and his financial activist backers to spread his “precision railroading” model across the continent, reduce operating ratios and return better value to shareholders. Harrison perfected scheduled freight train operation at the former Illinois Central Railroad, before moving on to Canadian National, and then coming out of retirement to do the same at Canadian Pacific (CP).

Harrison’s model certainly works as he has managed to improve the financial performance of every railway he has run. CP, for example, achieved a 58.6% operating ratio in 2016, which is a vast improvement over the 81.3% operating ratio recorded in the year preceding Harrison’s appointment as CEO. But it comes at a price with aggressive cost cutting and asset stripping.

However, some observers question whether Harrison’s model is applicable to CSX which had already announced plans to eliminate 1000 management positions, in addition to the 800 employees who have already left, in a bid to improve its 2016 operating ratio of 69.7%, its first sub-70 score. Doubtless more redundancies can now be expected.

CSX’s financial performance is already better than that of CP. Last year CSX reported annual revenues of $US 11.8bn and an operating income of nearly $US 3.6bn, approximately double that of CP.

As railway economist Mr Jim Blaze observed recently, in a blog published by our sister magazine Railway Age, being led by sharp cost-cutters in a declining-share and declining-volume market may be great for short-term current investors, but it will not work when a major dip in the market occurs.

Blaze points to a key challenge facing North American railways. “Despite a slowdown in growth and margin erosion in rail freight’s ageing core business, railroad management continues to focus on developing it at the expense of launching new growth businesses,” Blaze says. “In the process, management tries to swap asset ownership and downsize the asset scale. Eventually, investments in the railroad network core stop producing the previous growth that investors have come to expect. To revitalise the stock price, management often announces a targeted growth rate that may be beyond what the core business can deliver, thus introducing a larger growth gap and uncertainty.”

Blaze also points to another deficiency: rail’s aversion to risk. “The effect internally is that the railroads often reject or stretch out riskier projects that might generate payback. Internally, rail managers often respond with overly optimistic projections to gain funding for initiatives.”

These are issues that need to be tackled now at a time when traditional types of rail traffic such as coal face a very uncertain future. Failure to address them will jeopardise the long-term future of North American rail freight.

Moving across the Atlantic to Europe, the supervisory board of DB has made an historic decision to appoint Dr Richard Lutz, a career railwayman, as CEO rather than bringing someone in from outside, ending a decades-long tradition. As Lutz explained during a press conference to announce DB’s 2016 results on March 23, the day after his appointment: “I come from a railway family in southwestern Germany. And so, for me, being the CEO of DB is truly a job like no other: it is a job close to my heart.”

Lutz joined DB in 1994 and rose through the ranks to become responsible for group control and planning in 2003. Lutz has been CFO since 2010, a position he will retain which could prove troublesome in the future as the two jobs require different skills and have different challenges.

Lutz pledged to put all his energy into making DB a more attractive company, step by step. DB has certainly turned a corner having transformed a loss of €1.3bn in 2015 into a €700m profit last year. “The 2016 fiscal year demonstrated that the objectives of our Future Rail programme were the right ones: better quality, more customer focus and greater success,” Lutz says. Punctuality of both passenger and freight trains is improving - long-distance passenger traffic grew by 5.4% and passenger-km by almost 7% to 39.5 billion - although tonne-km fell by 3.8% to 95 billion. This is partly explained by the fact that open-access freight operators increased their market share from 27.5% in 2015 to more than 30% in 2016, a new record. Lutz says DB intends to defend its position with “strong products and top quality.”

For 2017 Lutz is forecasting an increase in revenue from €40.6bn in 2016 to €41.5bn and a growth in Ebit from €1.95bn to at least €2.1bn. “The first few months of the year are consistent with this assumption: revenue and Ebit performance is very encouraging,” Lutz says. “To sum up, 2017 got off to a very respectable start.”

While Lutz did not give much away about his vision for DB, one area he should address is DB’s rather parochial attitude in dealing with the outside world. Despite operating freight trains throughout Europe and passenger trains in many countries, DB still acts like a traditional national railway. DB has a good story to tell and needs to step out of the shadows.

David Briginshaw

David Briginshaw joined IRJ in 1982 as associate editor, and was appointed editor-in-chief in 2001. He has travelled the world extensively interviewing many of the CEOs and senior managers of the world's railways and transit systems which has given him an in-depth knowledge of the global railway industry.

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